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Mark McLaughlin CTA (Fellow) ATT TEP gives some Practical Tips when claiming a potentially Valuable Inheritance Tax Exemption. 

Normal Expenditure Out of Income

Many advisers, and some taxpayers, are aware of the Inheritance Tax (IHT) exemption for ‘normal expenditure out of income’ (IHTA 1984 s 21). Yet anecdotal evidence suggests that the exemption is not being fully utilised. Whilst most forms of tax relief or exemption have an upper limit (e.g., the Income Tax Personal Allowance or the annual CGT exemption), the IHT exemption for ‘normal expenditure out of income’ is not subject to an upper limit, so is effectively only restricted by an individual’s personal circumstances.

A gift will benefit from the normal exemption in IHTA 1984 s 21 broadly if, or to the extent that, it complies with certain conditions:

• the gift was part of the normal expenditure of the transferor, and
• that (taking one year with another) it was made out of his income, and
• that, after allowing for all transfers of value forming part of his normal expenditure, the transferor was left with sufficient income to maintain his usual standard of living.

Whether each of these three tests is satisfied needs to be considered separately, and will depend on the specific facts of the case.

Example

Fred, aged 78, has net income after tax of £50,000, consisting of pensions and investment income. He leads a modest lifestyle, and has been able to save a regular sum of £2,000 per month. Fred makes regular monthly gifts of £750 per month each to his son and daughter. HMRC accepts that the gifts were part of Fred’s normal income. The available exemption means that he can still make use of his annual IHT exemption of £3,000 per annum.   

The exemption is clearly very useful and valuable, and it is therefore unsurprising that HMRC will often check claims for the exemption. The following steps may be helpful when considering a claim:

• Record the gift – whilst financial records such as bank statements may show the gift, a simple, signed ‘Gift Memorandum’ or letter to the intended recipient is preferable, to confirm that the gift (and any similar gifts made) will leave the donor with sufficient income to maintain his or her usual living standards.
• Income and expenditure – It may be necessary to demonstrate to HMRC that the normal expenditure out of income conditions are satisfied. Donors may find HMRC’s Schedule IHT403 (page 6 – ‘Gifts made as part of normal expenditure out of income’) useful on an ongoing basis to record income, expenditure and surplus income each year.
• Be aware of HMRC’s internal guidance on the exemption, which is also available on HMRC’s website (at IHTM14231 and subsequent paragraphs).

The above article is reproduced from 'Practice Update' (July/August 2009), a Tax Newsletter produced by Mark McLaughlin Associates Limited.